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Zagami v. Cellceutix Corp.

United States District Court, S.D. New York

March 29, 2017

GARY ZAGAMI, individually and on behalf of all others similarly situated, Plaintiff,


          KATHERINE POLK FAILLA United States District Judge.

         In an Opinion and Order dated June 8, 2016, this Court granted the motion of Defendants Cellceutix Corporation (“Cellceutix”), Leo Ehrlich, and Krishna Menon (together, “Defendants”) to dismiss the Second Amended Complaint filed by Plaintiff Gary Zagami. See Zagami v. Cellceutix Corp., No. 15 Civ. 7194 (KPF), 2016 WL 3199531 (S.D.N.Y. June 8, 2016), appeal withdrawn (Sept. 6, 2016). Shortly thereafter, Defendants moved pursuant to the mandatory review provision of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”), 15 U.S.C. § 78u-4(c)(1), for a finding that the lawsuit amounted to “abusive litigation, ” and for the consequent imposition of sanctions pursuant to Rule 11 of the Federal Rules of Civil Procedure. For the reasons set forth in the remainder of this Opinion, Defendants' motion is denied.[1]


         A. Factual Background

         Critical to resolution of the instant motion is an understanding of the events underlying the filing of the three complaints in this matter. That history is presented, with appropriate detail, in this section. Familiarity with the Court's prior decision on Defendants' motion to dismiss, and with the scientific and financial terminology discussed therein, is presumed.

         1. The Parties to the Action

         Cellceutix is a clinical-stage biotechnology company developing several drugs for approval by the Food and Drug Administration (the “FDA”), including the drugs Kevetrin and Brilacidin. (SAC ¶¶ 2, 13). Defendant Krishna Menon has served as President, Chief Scientific Officer, Director, and Chairman of the Board of Cellceutix since 2007. (Id. at ¶ 14). Defendant Leo Ehrlich has served as Chief Financial Officer and Director of Cellceutix since 2007, and as the company's Chief Executive Officer since 2010. (Id. at ¶ 15).

         Plaintiff Gary Zagami purchased Cellceutix securities during the class period alleged in the SAC. (SAC ¶ 12).

         2. The Mako Research Report

         On August 6, 2015, a short seller of Cellceutix securities using the pseudonym “Mako Research” posted an article (the “Mako Research Report”) on the website Seeking Alpha; the author contended that Cellceutix was a “sham” company and purported to identify (and explain the falsity of) misrepresentations and omissions of material fact in the company's public statements. (See Sullivan MTD Decl., Ex. 1 (Mako Research Report); see also SAC ¶ 5 (alleging that Defendants' fraud “began to be exposed” with publication of the Mako Research Report)).[3]

         The Mako Research Report was the crux of Plaintiff's claims of fraud, and is now the crux of Defendants' motion for sanctions; it thus merits a detailed analysis. The Report is 38 pages long when printed out, with certain pages taken up by graphs, charts, and photographs. The thesis of the article was stated up front; it is lengthy, but worth repeating:

Cellceutix is run out of what appears to be an empty office building, and no one answers the phone - it appears that this is nothing more than a shell corporation.
CTIX science is demonstrably unviable, rendering this public shell likely worth substantially less than its current value.
The company is run by a management team with a long history of self-enrichment and shareholder value destruction.
One of these insiders has repeatedly issued false statements about his background.
CTIX is a black hole of related party transactions, enriching consulting agreements, and financing arrangements with known Ponzi scheme fraudsters as financing partners.
The company's fair value is 96-99% lower than the current price. CTIX should be avoided. This stock is dangerous.
I have been a professional investor for nearly a decade and have researched over 1, 000 stocks, and I believe that Cellceutix is far and away the worst public company I have ever seen. The company is rife with unethical conflicts of interest from insiders who appear to be recycling a historically effective playbook that has resulted in self-enrichment at the expense of minority shareholders. This team of insiders has been involved in numerous stock market wipeouts that have cost shareholders untold fortunes.
The “company” is run out of a shell office that was leased to CTIX by the company's president. Numerous calls to management went unanswered.
There is a strong probability that (OTCPK:CTIX) is manipulated by stock promoters and overseas boiler rooms, which is explained below.
Additionally, after hiring an independent scientist with a Doctorate in Biochemistry to review Cellceutix's “science, ” I have concluded that the company's drug pipeline is without merit and is likely entirely without value, as detailed below.
I value shares of Cellceutix at $0.09 in a best-case scenario, which is 96% lower than the current price, and recommend that investors avoid this company entirely. It's clear to me that Cellceutix is very likely to end up as a complete wipeout for shareholders over time, and stands to continue declining significantly if we experience more near-term market volatility. I am appalled that this company is even allowed to remain public, and recommend that the SEC immediately begin an investigation into all related parties and trading activity in CTIX stock.

(Sullivan MTD Decl., Ex. 1 at 1).

         In the succeeding 37 pages, the author added flesh to the bones of his thesis. On the issue of Cellceutix's office space (which presumably went to the bona fides of the company's endeavors), the author included pictures of the office “taken in early August 2015 during business hours.” (Sullivan MTD Decl., Ex. 1 at 2-3). The pictures show no one, and were presented to supplement the author's contention that repeated efforts to contact Cellceutix personnel by telephone were unsuccessful. (Id.).

         The author then spent six pages debunking the science behind the three pharmaceutical products that are the lifeblood of Cellceutix, prefacing his comments as follows:

As my research below demonstrates, the entire pipeline of drugs that the company boasts about continuously in its press releases is likely to be entirely without value. My conclusion is based on due diligence conducted by an independent Doctor of Biochemistry, who spent weeks researching CTIX's claims. This person is a published medical researcher who has extensive clinical trial research experience.

(Sullivan MTD Decl., Ex. 1 at 4). Addressing first the antibiotic Brilacidin, the author contended that the drug (i) was ineffective and caused adverse side effects in patients; (ii) had been purchased from a bankrupt company named PolyMedix (suggestive to the author of a prior market determination that the product had no value); (iii) would be “difficult to commercialize”; (iv) did not work as to most types of bacterial infections (particularly Gram-negative infections);[4] and (v) was ineffective in reducing the risk of infection for those experiencing oral mucositis. (Id. at 4-7). Proceeding next to the cancer-treatment drug Kevetrin, the author maintained that the drug did not target cancer stem cells, and was touted because of its effects on a biomarker gene, p21, that the author characterized as “invalid.” (Id. at 7-8).[5] Finally, and more summarily, the author criticized Cellceutix's anti-psoriatic drug Prurisol, which the author claimed was less effective than other drugs and had worse side effects. (Id. at 9).

         From here, the author proceeded to attack Cellceutix's senior management, beginning with Menon, who was alleged to have misstated or overstated his resume (including by reporting a degree from Harvard University that he did not receive), and to have had ties to other biochemical companies that “all … appear to be shell companies designed to enrich insiders.” (Sullivan MTD Decl., Ex. 1 at 10; see also Id. at 9-12). Along with his co-defendant in this case, Menon was identified as part of the “Ehrlich-Menon Value Destruction Team, ” with charts purporting to demonstrate the loss in value of securities at two other companies with which the two were involved, StatSure Diagnostics and NanoViricides. (Id. at 12-15). The two officers were also alleged to have been “tied up with Ponzi scheme financiers.” (Id. at 16; see generally Id. at 16-32).

         The post ended as it began: The author importuned investors to “completely avoid CTIX stock, as I estimate it has 96-99% downside from the current price.” (Sullivan MTD Decl., Ex. 1 at 35).

         3. The Filing of the Equity Alert

         A few hours after the Mako Research Report was posted, Plaintiff's counsel issued an “Equity Alert” news release, which stated in relevant part:

The Rosen Law Firm, a global investor rights law firm, announces it is investigating potential securities claims on behalf of shareholders of Cellceutix Corporation (OTC: CTIX) resulting from allegations that Cellceutix may have issued materially misleading business information to the investing public.
On August 6, 2015, Seeking Alpha published an article revealing that Cellceutix misrepresented the efficacy of its drug candidates Brilacidin, Kevetrin, and Prurisol. On this news, shares of Cellceutix fell sharply during intraday trading on August 6, 2015, damaging investors.
The Rosen Law Firm is preparing a class action lawsuit to recover losses suffered by Cellceutix investors. If you purchased shares of Cellceutix before August 6, 2015, please visit the firm's website at for more information[.]

(Sullivan MTD Decl., Ex. 18; compare Id. at 1 (reflecting issuance of Equity Alert at 12:41 p.m. Eastern Daylight Time), with id., Ex. 1 at 1 (reflecting posting of Mako Research Report at 10:30 a.m. Eastern Time)). The original plaintiff in this action, Nicole O'Connell, authorized the filing of a securities class action complaint that same day; she certified that she had read the Rosen Law Firm's proposed complaint and authorized its filing, but no complaint was in fact filed that day. (Compl., Ex. 1).

         4. Cellceutix's Response

         The next day, Cellceutix responded with a press release (the “August 7 Press Release”) that provided information regarding, among other things, four clinical trials in which it was involved. (See Sullivan MTD Decl., Ex. 2; SAC ¶¶ 26, 28, 45-47; see also SAC ¶ 5 (alleging that press release confirmed the falsity of certain of Defendants' prior public statements)).

         The August 7 Press Release comprised nine pages of small-font type, and endeavored to address each science-based criticism contained in the Mako Research Report by summarizing the criticism and then setting forth facts designed to refute it. First, as an easy retort, Cellceutix presented competing office photographs that depicted some of its employees. (Sullivan MTD Decl., Ex. 2 at 1-2). It then addressed more substantive matters, such as the Report's criticisms of Brilacidin, noting in part that:

The hyper-linked table provided by the shorter is misleading and irrelevant as it focuses exclusively on key Gram-negative bacteria. Brilacidin is for treating [G]ram[-]positive infections such as acute bacterial skin and skin structure infections (ABSSSI) caused by Staphylococcus aureus, including methicillin-resistant strains (MRSA), and was not developed for the treatment of Gram[-]negative infections.

(Id. at 2; see also Id. at 2-6 (setting forth additional point-by-point refutations of the scientific criticisms proffered by the author of the Mako Research Report concerning Brilacidin; noting, in particular, that arguments based on the drug's status as a peptide failed because Brilacidin was in fact a nonpeptidic mimic of an antimicrobial peptide)). And with respect to the Mako Research Report's claims regarding Kevetrin, Cellceutix rejoined that (i) the drug was still in a Phase 1 clinical trial; (ii) it had shown significant activity in combating cancer cells; (iii) it did not, and did not claim to, have any effect on cancer stem cells; and (iv) the clinical trial maligned by the poster was developed in consultation with experts at the Dana-Farber Cancer Institute. (Id. at 6-8).

         5. Other Reports

         Other reports were published in response to the Mako Research Report. First, on August 11, 2015, Dr. Richard W. Scott of the Fox Chase Chemical Diversity Center wrote to Seeking Alpha seeking a retraction of the Mako Research Report. (Def. Sanctions Reply, Ex. 3).[6] Scott detailed his prior involvement with the development team at PolyMedix (the entity from which Cellceutix had purchased Brilacidin), as well as the reasons why he considered the Mako Research Report's reference to an “unviable science” to be “patently untrue.” (Id. at 1).[7] Scott also dismantled arguments in the Mako Research Report that were, to him, so “specious and in certain instances laughable” that they caused him to doubt the author's references to consultation with an “independent scientist with a Doctorate in Biochemistry.” (Id.).

         Separately, Don Seiffert, the Life Sciences Editor of the Boston Business Journal, sought to investigate the Mako Research Report's “empty office” claims. On August 14, 2015, he published an article entitled, “My Visit to Cellceutix, the biotech that a short seller recently called a sham.” (Def. Sanctions Reply, Ex. 2). In preparation for the article, Seiffert met with Ehrlich and Menon to discuss Cellceutix's technology, and took a tour of the 12, 000-square-foot facility, including its labs. (Id. at 2).

         B. Procedural Background

         1. The Complaint and the First Amended Complaint

         Just over one month after the publication of the Mako Research Report, on September 11, 2015, the Rosen Law Firm filed a class action complaint on behalf of Nicole O'Connell against Defendants. The Complaint recited violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. ...

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